Important 6 Ratios to be verified before buying any stocks:
1) Earnings per share (EPS):
The portion of a company's profit allocated to each outstanding share. Earnings per share serve as an indicator of a company's profitability.
Calculated as:
= (Net income – dividend on stocks) / Average outstanding Share
When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of the period.
Diluted EPS expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number.
2) Price Earnings Ratio ( P / E):
Price to earnings ratio (P/E ratio sometimes referred to as the multiple) is the current price per share divided by a year’s worth of earnings per share (EPS) for a particular stock. It is an important indicator of perceived value.
Calculated as:
=Price of The share / Earnings per share
The Price to Earnings ratio (P/E ratio) is a simple way of evaluating company stock prices and comparing them against other stocks in the same industry. The P/E ratio mathematically depicts the relationship between the stock prices
3) Reserves:
Company divides it net profit (after subtracting Tax) into two portions. i.e. Reserves and dividend.
Dividend generally handed over to share Holders while Reserves generally kept for company’s future expansion Plan. So one can buy stock with higher Reserves. Generally when Reserves go twice its Share Capital (Only Equity) then we can say company is candidate of giving bonus issue.
4) Book value per share:
It is equals to the value of a company Reserves divided by the number of shares outstanding.
Calculated as:
= Reserves (Leass liabilities0 / Total quantity of equity
Book value is a good way of judging if the stock market value is reasonable compared to company's true value. Market value is usually higher than the book value. A good indication of safer investment is if the stocks market capitalization is close to the book value.
Market value is what the investment community's expectations are and book value is based on costs and retained earnings.
For example, if the market value is more than twice of the book value, company might be overvalued. However, buying a stock based only on a book value is not recommended. As always, other things need to be considered, such as: earnings, economic conditions, etc.
A thing to remember is that during bull markets the stock price is more likely to trade much higher than book value, and in a bear market the two value's may be much closer.
5) Dividend:
Dividends are payments that corporations make to people owning their shares. It is undoubtedly one of the best reasons why people buy equity, and it’s the company’s best way to reward its shareholders. Many public companies that make money will retain portions of their earnings and pay the rest out as dividends to all shareholders.
As described above For “Reserves”, dividend is a part of share holder’s fund. Generally it’s a talk that the company which gives good dividend every year will not / do not perform well because they are spending more money in dividend which directly lesser their reserves for future expansion.
It is more advisable to invest for capital appreciation rather than Dividend. So We can use dividend Yields as an indicator instead of dividend itself.
Yields indicates return you earned by dividend for your investment at current market price.
Calculated as:
= Dividend per share / Current market price of stock
6) PEG ratio( price / earnings to growth):
The PEG ratio is a formula used to estimate a stock’s value using its P/E ratio and its future earnings growth. Unlike the P/E ratio, the PEG ratio considers a stock’s earnings growth potential.
To calculate a stock’s PEG ratio, its P/E ratio must be further divided by its projected earnings growth rate.
Calculated as:
= (P/E ) / Expected growth of company’s EPS
A stock with a PEG ratio less than 1 is considered undervalued (and generally a good buy); greater than 1, overvalued. Of course, a PEG ratio of 1 indicates a stock with a fair value. The PEG ratio is not a firm measurement but simply a guideline, and the PEG ratio should not be used as the sole indicator of a stock’s under- or overvaluation. In addition, a PEG ratio of a stock should only be compared with PEG ratios of stocks from companies in similar sectors. This will ensure consistency during analysis.
